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Good day Sir . In the question Airline Bbusiness part B, i understood the part were they calculated the effect of the new issue on the current bond which had a yield of 4% and was then adjusted to 4.4%. The part were the basis points was reculculated to arrive to basis points of 110 confused me. This was the used to reduce the MV of the current debt as follows (100%-1.1%) = 98.9%*400m. Is there another way to calculate the adjusted MV of debt which i can understand better. Thanks.
For every 100 nominal, currently there would be interest of 4 per year for 3 years, and a repayment of 100 in 3 years time.
If you discount these flows at the current 4% then it gives a MV of $100 for every $100 nominal.In future the coupon rate is still 4%, so the flows on 100 nominal will be $4 a years for 3 years and then a repayment of 100 in 3 years time (as before).
However if you discount these flows at the new rate of 4.4% you will get a new MV of $98.9 for every $100 nominal.
I hope that helps 🙂
Hi John,
My understanding of the formula, yield+credit spread = cost of debt. However, the answer uses this formula to calculate coupon rate. Coupon rate= yield + spread= 5.1%+0.9%=6%
Does this mean that the coupon rate that should be applied to the new debt issue to ensure it is fully subscribed is coupon=cost of debt which also means the bond will be issued on par? In this case, why would coupon=cost of debt ensure it is fully subscribedIs it correct to say that the cost of debt determines the market value of the debt. Therefore, the answer, ” If the company’s investment bankers set the spread too high, the debt will be issued at premium and if the spread is set too low, the debt will be issued at a discount” Does the spread refer to the credit risk spread which is mentioned in the question and is this sentence referring to the cost of debt or coupon?
It is the investors required rate of return that determines the market value (which is the pre-tax cost of debt because investors are not affected by company tax).
If it is a new issue, then in order to give the investors that required return then (assuming the issue is at par) then the coupon rate has to be the same as the required return.
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